The benefit of starting early with investing to benefit from the long-term power of compound interest – the effect of investment returns themselves generating future gains – has been well documented.
However, making your first foray into the world of investing can be daunting. There are thousands of funds to choose from, which can prove overwhelming.
For younger investors, going down the DIY route and making your own investment decisions is often the only option due to not having enough money to be taken on by a financial adviser or wealth manager. Moreover, the fees charged on a small pot of money also prove prohibitive.
This was exactly the predicament faced by the latest interactive investor customer to participate in our DIY Investor Diary series, which highlights how people at different stages of their investment journeys are investing.
The 25-year-old male, who opened his first stocks and shares ISA in the summer of 2022, sought financial advice but was told he needed £250,000 to get on the books.
The adviser, however, did pass on plenty of his expertise free of charge, which helped the investor shape his ISA.
“I’ve stayed in touch with the financial adviser, but due to being at the start of building up my ISA, I have to go down the DIY route.”
An important consideration was to avoid taking on too much risk, with the investor saying that he “would sooner sacrifice higher returns for reliability”.
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“I've learnt the importance of diversification, which is why I have spread my ISA across four funds,” he says.
A separate pot of money – held in a savings account – is earmarked for a future house deposit.
Therefore, with no short-term financial objectives he has no plans to touch the ISA for a long time, potentially 20 years. This has led him to pick funds that he aims to hold for the long term.
“I'm hoping that each of the funds provide a decent foundation and can be held for a long time. The infrastructure fund hasn’t got off to a good start, but over the long term this is a trend that’s not going away as there’s always going to be money spent on infrastructure.”
He is aiming to use as much as he can of the ISA allowance, which stands at £20,000 per tax year. In addition to the ISA, he has a workplace pension and a separate private pension. He says he treats the monthly contributions he makes to the private pension “like a bill”.
For the ISA, he built up positions through lump sum investing, but also invests regularly on a monthly basis.
“I don't have any major outgoings, apart from rent. This allows me to aim to maximise the amount I can put into the ISA for my future.”
Each tax year, the investor is aiming to add one new fund, as well as topping up his other holdings. His latest investment, purchased in November, is BlackRock Throgmorton Trust (LSE:THRG), which invests in UK smaller companies. Smaller companies are a riskier area of the market, but he says he's now prepared to add more risk to the ISA given he has “a solid foundation in place”.
“I am planning to add a fund each tax year as the ISA becomes bigger, but up to a certain point, as I want to avoid over-diversifying. At a later stage, I would like to add some individual stocks.”
In the meantime, he has a separate trading account, in which less money is held. He is prepared to take on more risk with this part of his portfolio and views it as a bit of “fun money”, which gives him an opportunity to act on new ideas, including investing in some individual stocks.
“I read widely and try to pick up stuff along the way. I have a notebook and jot down ideas in that, and then look into the idea further.”
Whatever your investment persuasion, whether you prefer to invest in funds, shares or simply to passively “buy the market” through an index fund or exchange-traded fund (ETF), there is one thing that should not be underestimated: the power of compound interest, achieved through investing for the long term.
For those not in the know, here’s how compounding works. If you invest £1,000 into a fund returning 5% over one year, you'll earn £50. Assuming you don't withdraw any money, the next year you'll earn 5% on £1,050, which is £52.50. This doesn't sound like much of an uplift, but as each year passes, the compounding effect multiplies.
Investing as early as possible provides a longer time frame for compounding to work its magic, as figures from a financial calculator on Candid Money show. For example, let's say at age 25 you invest £10,000 as a lump sum and make monthly contributions of £200 a month – with a 5% yearly return achieved (after charges). At age 60, the pot would grow to £774,188. If the investor started at age 35, investing the same figures and receiving the same 5% return, the pot would be worth £456,256.
By investing early and resisting the temptation to sell, the 25-year-old investor is in a great position to reap the rewards of compounding.
“The way I see it is that investing as much as I can at a young age is paying my future self. I am investing early in order to be able to retire comfortably.”
In our DIY Investor Diary series, we speak to interactive investor customers to find out how they invest in funds and investment trusts, what their goals and objectives are, current issues and concerns regarding their portfolio, and what they’ve learned along the way. The premise is to try and provide inspiration for other investors, and we would love to hear from more people who would like to be involved. We do not require those featured to be named. If you are interested, please email our collectives editor directly at: firstname.lastname@example.org
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.
Please remember, investment value can go up or down and you could get back less than you invest. If you’re in any doubt about the suitability of a stocks & shares ISA, you should seek independent financial advice. The tax treatment of this product depends on your individual circumstances and may change in future. If you are uncertain about the tax treatment of the product you should contact HMRC or seek independent tax advice.